Toro's Running of the Bulls Market Blog

What the Future Holds

This is an excellent post from China Financial Markets.  The abridged version is

1. The euro will not survive in its current form.
2. This crisis rivals the Great Depression but is more like The Long Depression of 1873.
3. The European crisis will be accompanied by a trade shock which will bring about a significant contraction.
4. The recovery in countries affected by the crisis will not begin until their debt is written off.
5. This will go on for many years.

Hey Saskatchewan - Don't Build a New Dome Stadium. Buy the Silverdome!

I am from the province of Saskatchewan.  Wonderful place, if you can handle weeks on end of -40C in the winter.  People are lovely.  Friendly too.

Unfortunately, they now have too much money.

Several years ago, I flagged the opportunities of Saskatchewan, as well as the nuttiness of the local economy.  When I grew up there in the 70s and 80s, it was flat broke.  Saskatchewan's biggest export was people.  Farmers were receiving hundreds of millions of dollars from Ottawa to bail them out because grain prices were so low that the farm economy was effectively bankrupt.  The government was utterly incompetent, spending hundreds of millions of dollars on subsidies for people to upgrade their homes, i.e. build whirlpools in their back yard.  The province's bonds were rated junk.  The pension fund of the capital city, Regina, was prohibited from buying the province's bonds because they weren't investment grade.  

But now, Saskatchewan is the quintessential asset-driven economy play.  It is blessed with commodities.  Saskatchewan is a major producer of grains such as wheat and canola.  It has vast deposits of potash.  And it may have extensive reserves of oil and gas, too.  The Bakken Formation extends into Saskatchewan, and some speculate that there are oil sands in the western part of the province.

In other words, Saskatchewan is loaded.

Too loaded, in fact.  It is a common phenomenon that people without money who get money sometimes blow it on unwise things.  And that is what the people of Saskatchewan may be on the verge of doing.

The City of Regina is examining the possibility of building a domed facility to replace Mosaic Stadium.

Regina Mayor Pat Fiacco said Tuesday the city is looking into what it would cost to build a domed stadium, if the move would be financially practical and how it would be funded.

“We’re doing our due diligence and we’ll go from there,’’ Fiacco said Tuesday. “It has to be affordable but we all know that it takes a bit of an investment. Someone had the vision to build Mosaic Stadium or Taylor Field at the time. For obvious reasons, we have to make sure that we take care of the next 50 years.’’

Fiacco said it was too early to speculate on the costs, size or site of the new facility. He said the city would like to build the facility close to where Mosaic Stadium is currently located.

Fiacco said that the domed stadium would be more than a home to the CFL’s Saskatchewan Roughriders, who are the primary tenants of Mosaic Stadium.

Now, I'm a huge Riders fan.  All of us from the province are.  But a domed stadium?  In Regina?

Regina

Regina has a population of 200,000.  Saskatchewan has a population of 1 million.  The province had a population of 1 million 50 years ago. 

The estimated cost of building a domed stadium in Regina is $386 million.  Given The Law of Stadium Costs - the actual cost of building a stadium will be on average double the initial estimate - such a stadium may wind up dinging the taxpayers of Saskatchewan a cool $750 million. 

This, to me, seems nuts.  The province almost went belly up in the 1990s due to incompetent government schemes and spending and a near depression in the farm economy.  A commodity-based cyclical economy without many people probably should be using its money prudently, not blowing it on extravagances such as a shiny new sporting arena.  It reminds me of those guys buying five condos on the beach they could not afford, financing it with subprime ARM loans, thinking the party will never end.

Given the fondness in my heart for my home province, I propose a better solution.  Instead of building a new domed stadium, buy the Pontiac Silverdome!  Last year, the former home of the NFL's most hapless franchise was sold for a mere $583,000.  Factoring in the The Law of Stadium Costs, that is 0.07% of the prospective cost of a domed stadium in Regina.  Think of the savings!

Of course, this presents a bit of a problem since Pontiac is in Michigan, 1351 miles from Regina (2163 km for my Canadian readers).  How do you get the Silverdome to Regina?

Well, I don't know. Someone else can figure that out.  Maybe they can dig it out of the ground, plop it on a few trucks, and drive it to Regina.  You know, like those big trucks that move pre-manufactured homes place to place, with the smaller trucks decked out in orange and yellow trailing behind, going 20 mph below the speed limit.

Or maybe the province can just fly everyone to Michigan.  They could spend $700 million transporting all the spectators to the Silverdome.  They would still be better off than building a domed stadium.

That may not make much sense, but it seems to make a whole lot more sense than a province the size of Texas with the population of San Jose CA and one of the most cyclical economies on the planet that was just recently on the brink of bankruptcy building a domed stadium for hundreds of millions of dollars.

Gold Popular with Central Bankers

I'm not sure if this is a good or bad thing, considering how awful the economists who run central banks were at selling their positions for most of the past 10+ years or so.  Having said that, central banks will provide a leg underneath the gold market for at least the intermediate term.  From the FT.

For two decades central banks were net sellers of gold but that trend has reversed as central banks in Europe are scaling down their sales and others, such as China, India and Russia, are making significant purchases.

Asked what the most important reserve asset would be in 25 years, about half of officials polled by UBS said the US dollar but 22 per cent pointed to gold.

Bullion was the second-most popular response, well above others such as Asian currencies or the euro.

UBS surveyed more than 80 central bank reserve managers, sovereign wealth funds and multilateral institutions with more than $8,000bn in assets at its annual seminar for sovereign institutions last week. The results were not weighted for assets under management.

The reversal of the trend of central bank gold sales has boosted sentiment towards the metal while removing a significant source of supply. ...

The central bank managers believe gold will be the best-performing asset class in the next six months, ahead of equities, bonds, oil and currencies, according to the poll. ...

GFMS, the precious metal consultancy, estimates that central banks last year sold 41 tonnes of gold, down 82 per cent from the low of 2008 and the lowest level in 20 years.

Philip Klapwijk, chairman of GFMS, said central banks were more likely to be buyers than sellers for the first time in two decades. But he said: “I will be surprised if we see multi-hundred-tonnes purchases.”

There has not been a sustained period of significant central bank gold purchases since the 1960s.

Investment Book Log Updated

I have updated the investment book log.  These are the official recommended books of Running of the Bulls, a highly coveted distinction in the world of business publishing,** sorted by general category.

Accounting

Financial Shenanigans

Bubbles

Extraordinary Popular Delusions and the Madness of Crowds

The Great Crash 1929*

Devil Take the Hindmost*

Manias, Panics and Crashes*

Buffett, Warren

Buffet: Making of an American Capitalist*

Trade Like Warren Buffett

The Warren Buffett Way

 

Central Bankers

Greenspan's Bubbles Review

 

Commodities

Hot Commodities

Cramer, Jim

Confessions of a Street Addict 

Trading with the Enemy*

 

Derivatives

Dear Mr. Buffett Review

Fiasco*

Fool's Gold

Infectious Greed*

Traders Guns & Money Review*

Economics

Economyths

 

The Eighties

Barbarians at the Gate*

Den of Thieves*

Liars Poker*

Money Culture

The Predator's Ball

 

 The Euro

Bust: Greece, the Euro and the Sovereign Debt Crisis  Review*

 

The Financial Crisis

Diary of a Very Bad Year  Review*

The Death of Capital  Review

 

Fixed Income

On Money and Markets

General Business

Chainsaw: The Notorious Career of Al Dunlap *

DisneyWar*

 

History

Eyewitness to Wall Street

Markets, Mobs and Mayhem

The Myth of the Rational Market  Review*

This Time is Different*

Tomorrow's Gold*

Toward Rational Exuberance

Wall Street, A History

Investors / Traders

Inside the House of Money Review

Investment Gurus

Just One Thing  Review

Lessons from the Greatest Stock Traders of all Time

Market Wizards

The New Market Wizards

Irrationality

How We Know What Isn't So*

The Little Book of Behavioral Investing*

Mean Markets and Lizard Brains Review*

Predictably Irrational*

Why Smart People Make Big Money Mistakes and How to Correct Them Review

Levy, Leon

The Mind of Wall Street

Livermore, Jesse

Jesse Livermore, World's Greatest Trader

Reminiscences of a Stock Operator*

Long-Term Capital Management

Inventing Money

When Genius Failed*

Non-Normal Distributions

The Black Swan*

Fooled by Randomness*

Ubiquity: Why Catastrophes Happen*

 

Quants 

A Demon of Our Own Design Review

Real Estate

Greater Fool Review

Rich, Marc

Metal Men*

Rogers, Jim Travel & Investment Adventures

Adventure Capitalist

Investment Biker

Shorting

The Art of Short Selling

Selling America Short*

Soros, George

Soros The Unauthorized Biography

Strategy

Beating the Street

Contrarian Investment Strategies: The Next Generation*

The Intelligent Investor

Invest Like a Shark Review

The Little Book that Beats the Market

One Up on Wall Street

Stocks for the Long Run

Unexpected Returns: Understanding Secular Stock Market Cycles Review

Wall Street Revalued  Review

You Can Be a Stock Market Genius*

Tech Bubble

Bull! 144 Stupid Statements from the Market's Fallen Prophets*

Bull! A History of the Boom, 1982-1999

Blood on the Street Review

Dot.con

Origins of the Crash Review

Wall Street Meat

*Highly recommended

**Sarcasm

China – Rising Costs, Lower Returns

I am seeing all sorts of commentary regarding the de-pegging of the RMB to the dollar as being positive for risk assets.  And it is, long-term.

Over the long-term, a floating Chinese currency is enormously positive as it will help alleviate the enormous imbalances in the world economy.  Simply put, the imbalances are that the US consumes too much and China produces too much, which has led to an unstable build-up of foreign currency reserves in China.  China must consume more and the US must produce more.  A rebalancing of the Chinese currency will help do both by making imported goods into China cheaper while making exported Chinese goods more expensive, leading to lower growth in Chinese currency reserves.  But over the short and intermediate term, this could produce headwinds for US stocks.

There will be pressures on businesses other than a rising Chinese currency, however.  Labor costs are rising in China, which means labour costs will start rising again in the developed world.  Because Chinese labour costs are rising, offshoring will become less ubiquitous and profitability will fall.

I believe that we are witnessing an inflection point in the construct of the global economy that could have enormous ramifications for how the spoils are divided up between capital and labour.  Over the past decade, those spoils have accrued primarily to capital whereas labour has lived off crumbs.  I believe that we are shifting to a more equitable distribution of wealth. And though I doubt we will see a reverse of the past decade such that all the gains accrue to labour and capital gets little, the gains will be more evenly distributed.

More to labour, less to capital

The biggest benefactors of the opening of China over the past decade have been the owners of capital.  The opening of China has shifted global cost curves down.  Companies have been able to shift productive capacity overseas, which has increased profitability and returns on equity.  Many measures of corporate health during the 00s hit either all-time highs or multi-decade highs – profit margins soared, return on equities skyrocketed, profits as a percentage of GDP exploded, etc.

Labour, on the other hand, experienced stagnant income growth, at least in the developed nations.  Productive capacity shifted offshore, pressuring wages.  Consumption growth was often financed by debt and home equity extraction, not by growth in income.

Even in China, which has seen enormous gains accrue to labour over the past decade, there is widespread discontent amongst the have-nots as income disparities have raised significantly over the past 10 years.  There have been several high profile reports coming out of China lately about worker discontent at plants and factories.  Workers have gone on strike and have received significant wage gains.

Wages are going to rise in China relative to capital as Beijing attempts to create more internal consumer demand within the country to rebalance the economy and to keep the social peace.

This cannot be overstated enough – if the cost structures of global corporations are rising, as accelerating wages in China and a higher RMB implies, there will be headwinds for corporate profitability growth, and gains to the owners of capital will be lower.

Rising costs in China will mean fewer options for corporations to lower costs by moving production offshore.  Costs for corporations are going to rise at the expense of profitability as companies pay their employees more domestically.  Profit margins are going to fall, return on equities will be lower and the percentage of profits to GDP will decline.  Good for labour, bad for capital.

Over the long-term, the developments in China are extremely positive as they assist in the rebalancing the enormous imbalances in the global economy.  Over the short and intermediate-term, however, they will slow aggregate profitability growth.

Less demand for dollars

Perhaps the most destabilizing imbalance is the enormous amount of currency reserves held by the People’s Bank of China.  Over the past decade, the Chinese currency peg has kept interest rates in the United States lower than they otherwise would have been.  To keep the RMB low, the PBOC purchased US dollars and used those dollars to buy US debt, primarily Treasury and agency bonds.  This demand for US government bonds kept a lid on interest rates.

A rising RMB means there will be less imperative for the PBOC to buy US bonds to keep the RMB low.  Less demand for US bonds will mean higher interest rates.  Higher interest rates means lower valuations for risk assets, which means lower returns for equities.

Less liquidity

The downward shift in global cost curves kept interest rates low as the opening of China was deflationary.  Central banks don’t like deflation, they like price stability.  To counter deflation, central banks created money, which is inflationary.  The money supply grew at a faster rate than economic growth. 

Much of this liquidity found its way into asset prices, particularly real estate prices but also commodities, credit and other more esoteric assets such as wine and sports teams.  A rising cost structure in China will reduce deflation, which means there will be less money creation to counteract deflation, thus less liquidity.  Less liquidity will mean less fuel for assets.  Less demand for assets will mean lower returns for risk assets.

The end game

The effects of a rebalancing Chinese economy towards more consumption will mean lower aggregate profitability growth, higher interest rates and less liquidity in the financial system, all of which are negatives for stocks over the intermediate-term.  This does not mean that stocks are going to fall but it does mean that returns to equities will probably be substandard.  Over the long-term, the effects will be positive as they will strengthen an unhealthy global system.

Of course, over the intermediate-term, there will be winners and losers.  Obviously, corporations selling to the burgeoning Chinese consumer will benefit.  However, companies that relied on offshoring are going to see lower profitability.  Profit margins are likely to be lower over the next decade than the past decade as less offshoring will mean less pressure on wage growth in the developed world.  This will alleviate (though not eliminate) the pressure on the American consumer caused by deleveraging, thus benefiting the American consumer.

I believe this shift in trend will occur over the next 10 years, and will happen slowly and subtly.  The opening of China has been and will continue to be one of the most significant economic events of the past 100 years.  However, the composition of wealth distribution caused by the opening of China is changing, I believe, which is going to have a significant effect on asset returns.

 

Bernanke "Doesn't Understand" Why the Price of Gold is Going Up

From Real Time Economics

“I don’t fully understand movements in the gold price,” Mr. Bernanke admitted.

Awesome.

As a gold bull, nothing warms my heart more knowing that the head of the most powerful central bank on the planet does not understand why the price of gold is going up.  Since he, his colleagues at the Fed and his predecessor are significantly responsible for the gold bull market, they are going to keep doing what they have been doing and will keep the party going.

Gold Sentiment Not High

I have had several conversations with investment professionals over the past few days regarding gold.  I have been asked by people in the investment business what they should do with their money, given the low prospective returns for most asset classes.  I asked them if they are invested in the only bull market going, gold.  The response?  Skepticism.  All but one said "No." They don't understand it, they tell me.  I tell them that it is much easier to make money in a bull market than in a bear market, but no dice.  They have no interest.

Most fund managers do not own gold.  And those that do, own a very small portion in their fund.  Except for some hedge funds and a few vocal gold bulls, the professional money manager is not there.  Nor is the retail investor.  Despite gold pushing all-time highs, and despite what the gold bears might say, investors are not All In on gold. 

From Barron's

GOLD'S NEXT ATTEMPT AT breaking through its previous all-time high is likely to be successful.

That at least is the conclusion reached by a contrarian analysis of gold market sentiment. The gold timers are remarkably subdued right now, even as gold bullion trades within shouting distance of that previous high.

This suggests to contrarians that there's a robust wall of worry out there for a gold-bull market to climb.

Consider the average recommended gold-market exposure among a subset of short-term market timers tracked by the Hulbert Financial Digest (as measured by the Hulbert Gold Newsletter Sentiment Index, or HGNSI). As of the middle of last week, HGNSI stood at 30.5%, which means that these timers on average are recommending that their clients have some 70% of their gold-oriented portfolios in cash.

To put this high-cash position in context, consider that the HGNSI in January stood at 60.9%, double where it is now. At the time, gold bullion was trading around $1,130 an ounce.

In midday trading Monday, gold was trading at around $1,240 an ounce, near its all-time high.

In other words, the net effect of the gold market's gyrations over the last six months has been to add more than a hundred dollars to gold's price while simultaneously leading the average gold timer to cut his recommended gold-market exposure in half.

It's rare to see such a marked divergence, since the almost universal tendency is for market timers to become more bullish as the market rises and more bearish as it declines.

The current sentiment situation is therefore quite different from what prevailed in early December, the last time I devoted a Barrons.com column to a contrarian analysis of gold's prospects. On that occasion, the HGNSI stood at 68%, even higher than where it was in early January.

Contrarians therefore were not surprised that gold struggled over the next couple of months. At its February low, in fact, bullion was 12% lower than where it stood when the HGNSI was as high as 68%.

To put the gold timers' sour mood into perspective, imagine how bullish and exuberant stock market timers would be if the Dow Jones Industrial Average were trading within shouting distance of its all-time high above 14,000 -- four thousand points higher than where it is now. To match gold timers' current mood, though, the stock market timers in that otherwise happy scenario would have to have the bulk of their equity portfolios in cash.

Hard to imagine that happening, isn't it?

Also, witness Robert Prechter

Prechter said at the Reuters Investment Outlook Summit in New York that recent readings of gold market psychology showed a 98 percent bullishness in the metal, the highest ever recorded for any physical commodity.

He said, however, that technical momentum was stalling for gold as the rate of increase had peaked in 2006, and that each subsequent rally since then has risen at a slower rate.

"That is not a guarantee of change but a sign that one is likely."

In January, he had forecast that gold could drop at least 40 percent from its peak value because of deflation and over-ownership.

Asked if Prechter still expected gold to correct 40 percent, he said that extremes in technical indicators still "leave gold vulnerable to that large of a decline."

"I still feel that gold is not going to the moon here. It's not a market that you want to be long, just as you didn't want to be long stock in the first quarter."

I have no idea where Prechter gets his data showing that gold psychology was "98 percent bullish" given the skepticism I see.  Gold tends to be owned by people who see it as a religion, not as an investment.  We are nowhere near the euphoria seen in the Housing or the Tech Bubbles.

Nor do I understand Prechter's comment about momentum slowing.  In fact, gold has taken only eight months to hit new highs compared to ~18 months after the peaks in 2006 and 2008.

I see this chart as being very bullish.

Prechter, though, has a poor record as a near and intermediate term prognosticator.  Of the 58 "investment gurus" tracked by the CXO Advisory Group, Prechter ranked 57th, getting it wrong three quarters of the time.

I noted a week ago that relative to other bubbles, gold has some ways to go.  David Rosenberg of Gluskin Sheff notes the same thing.

(HT: The Big Picture)

What worries me is that gold has been going up recently because of fear.  In this 9 year gold bull market, liquidity and currency debasement have been the primary drivers of the price of gold.  Both are long-term structural issues that are difficult to reverse.  Fear is different.  Fear can change on a dime. 

However, I will not quibble with the market.  It appears to me that gold wants to go higher.  Who am I to argue?

I am very long gold.

ECRI Index Heads Down

From FT Alphaville.

BP Ad c1999

HT Mark Thoma